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Disclaimer
Taking A Look Behind Hedge Funds
Once dismissed as secretive, risky and only for the well-heeled, hedge funds represent a growth industry. They can promise higher-than-average market returns in a downtrodden market, but despite the allure of these alternative investment vehicles, investors should think twice before taking the hedge fund plunge.
What Are Hedge Funds?
Hedge funds are privately offered investments that use a variety of non-traditional strategies to try to offset risk, an approach called - you guessed it - hedging.
One such technique is short selling. Hedge fund managers identify a stock in which price is likely to decline, borrow shares from someone else who owns them, sell the shares and then make money by later replacing the borrowed shares with others bought at a much lower price; buying at this lower price is possible only if the share price actually falls.
Hedge fund managers also invest in derivatives, options, futures and other exotic or sophisticated securities. Generally, hedge funds operate as limited partnerships or limited liability companies and they rarely have more than 500 investors each. (For more read Getting To Know Hedge-Like Mutual Funds.)
Arguments for Hedge Funds
Some hedge fund managers say these funds are the key to consistent returns, even in downtrodden markets. Traditional mutual funds generally rely on the stock market to go up; managers buy a stock because they believe its price will increase. For hedge funds, at least in principle, it makes no difference whether the market goes up or down.
While mutual fund managers typically try to outperform a particular benchmark, such as the S
